Is Opec+ carrying out a reset, a rebound or a revolution? By the middle of next year, we will have a clearer idea of which of the three Rs it favours – but that is a long time to wait. Even the ministers and strategists who meet in their virtual Vienna may not be sure, but deciphering the question is crucial to the oil exporters’ diverging prospects.
This month, the extended Opec+ group agreed to start easing the next 1.65 million barrels per day tranche of voluntary cuts. These were made by an eight-member subset of the leading producers: Saudi Arabia, Iraq, the UAE, Kuwait, Russia, Kazakhstan, Algeria and Oman. They had already eliminated the first of 2.2 million barrels of these voluntary cuts the month before.
Now, from October, allowable production will increase by 137,000 bpd. If this were repeated each month, then after a year, the second tranche will be eliminated. That would leave only the third set of cuts, totalling 2 million bpd, chronologically the first made, which date from October 2022. Unlike the voluntary cuts, these were binding on all Opec+ members, except three exempt for political reasons – Iran, Libya and Venezuela.
In case this simplification might make the sums too easy for analysts, it is complicated by the revision of “compensation cuts”, through which some countries are meant to fill in for overshooting. Most of this falls on Kazakhstan and Iraq, and to a lesser extent, the UAE and Russia. The latest update largely defers this compensation to next year.
If taken literally, the new compensation schedule would actually reduce production from Opec+ next year, even accounting for the latest permitted increase. But no one really expects Kazakhstan to follow through.
These production increases have been a success, from the point of view of Opec+. The group announced the first step of its more aggressive easing policy just hours after US President Donald Trump’s April 2 tariff headline had brought down oil prices sharply. Since then, prices are actually up slightly. Production from the group of eight has increased almost 4.5 per cent from April to August, translating to an overall revenue gain.
Stronger than expected demand, and, probably, large gains in Chinese inventories, have helped soak up any surplus. That could change in the fourth quarter, as Middle Eastern oil consumption for power drops, permitting higher exports, while demand generally is expected to soften. The International Energy Agency sees a fourth-quarter glut as high as 3.1 million bpd, although that is not apparent in the data yet.
The next moves by Opec+ will show what approach it has in mind: reset, rebound or revolution. In the case of reset, it will continue to increase allowable production month by month, and monitor the market. By next June, it would have worked off all the voluntary cuts. The real oil flowing to market will be much less than the headline 1.65 million bpd, perhaps half that, as several members of the group of eight hit the limits of their capacity.
Saudi Arabia could then seek a general realignment of production baselines. These date from October 2018, with a few adjustments, and have become ever more outdated. The group has already planned for an independent consultancy to assess real production capacities, to inform new baselines in 2027. Nevertheless, such a reset will be very controversial.
The UAE, Iraq and Kazakhstan would expect substantial increases because of their investment in new capacity – but why should Kazakhstan, which has heavily overproduced, be rewarded? If the heralded oversupply arrives and Opec+ then decides on an overall cut in output from its new, higher level, others would have to give some ground. Riyadh will not want to bear the burden again, so to have an impact, reductions would have to come from other large producers, notably Russia.
The required consensus could be achieved in three ways. A period of low oil prices, say below $60 or even $50 a barrel – would convince waverers that a new framework for cuts was required. To sustain oil prices to fund its continuing war, Moscow might have to concede on production levels. Or, the end of the voluntary cuts would reveal who can live up to their production targets, and who cannot. Alternatively, stiffer sanctions on Russian oil or intensified Ukrainian attacks might finally cut its exports substantially.
Outside the group of eight and the exempted three, the other Opec+ adherents are mostly small producers without spare capacity. The main exception, Nigeria, has enjoyed a good year and might have a case for a stronger baseline. Libya, though exempt, could also prove tricky if its recent period of relative stability in the oil sector persists, and if it is able to mobilise its planned production gains. Can it remain outside the baseline system indefinitely?
The rebound case would result in Saudi Arabia and its main allies recovering market share to around the 2022 level, before the two big wedges of voluntary cuts were made. That might come at the cost of significantly lower prices next year, depending on the trajectory of the global economy. Production would be set ad hoc as it becomes clear who really has spare capacity.
The revolution scenario is the most intriguing. The leading lights in Opec+ would make a sustained push for higher output levels and gaining – not just regaining – market share. They would move to eliminate not only the voluntary cuts, but the remaining 2 million bpd of group-wide reductions. Of course, that would mean prices dropping substantially, probably to below $50 a barrel.
Such a strategic shift would aim to moderate inflation and hence prop up economic growth in the short term. In the longer term, it should sustain oil demand, and squeeze out competing supply. US shale production could be deterred during the next year. But it would take some years to diminish the longer lead-time output from countries such as Canada, Brazil and Guyana. A bigger impact might be within the Opec+ group itself, by starving budgets for more costly projects.
Opec+, and within it Opec, have generally moved flexibly, both anticipating and reacting to market developments. The group still faces all the difficulties of co-ordinating a disparate group of countries. Whichever of the three Rs it opts for, all the key members need to see that the sums add up.
